Tuesday’s kiwi downside invalidates yesterday’s weekly strategy but in its place has set the framework for a technical breakout play. Taking a top down approach provides some clarity as to potential NZD direction.

Starting with weekly charts:

Since 1997, there have been three weekly closes below the 100-week SMA. Each has preceded extreme levels of risk aversion and concurrent NZD/USD downside due to its high beta to risk.

June 27, 1997; -2930 pips

Dec. 23, 2005; -850 pips

Aug. 1, 2008; -2464

Average downside; -2081

Switching gears to daily charts, a massive H&S top formation projects a move towards the 0.6000 figure on a daily close below 0.7525. NZD/USD currently trades around 0.7513 (see weekly chart below).

Furthermore, the break below the potential bear flag on hourly charts projects to the 0.7400 figure; below the neckline of the H&S neckline which may see 0.6000 in view if global headwinds stemming from Europe intensify (see daily chart and inset hourly chart below).

WEEKLY STRATEGY (UPDATE 1): Kiwi heads & shoulders below the rest

We think selling NZD/USD around 0.7520 with stops above the 100-week sma at around 0.7875 for a total risk of about -360 pips and final limits targeting further downside to the 0.618 retracement of the 2009 lows to 2011 highs at around 0.6420 a total potential reward of about +1100 pips may provide 3:1 reward to risk value for kiwi bears.

At the moment, EUR/USD hovers just above the 1.2800 figure as expectations of further policy easing from global central banks sees USD offered across the board. Fundamental risks to a sustainable global economic recovery still remain with the possibility of Greece exiting the Eurozone being the most immediate. The most threatening risk to the global economy, however, is the potential for EZ peripheral debt contagion resulting in not just the PIIGS getting slaughtered but risk assets overall taking a beating.

Risk back on or short covering?

Despite the rebound in G10 and EM FX vs. USD over the past two trading days, it’s hard to believe risk being put back on the table considering the heavy spate of data/events in the month ahead – BOJ meeting & more importantly EU meeting on Wednesday, US GDP and NFP next in a few weeks, and Greek elections mid-June. Short covering seems to be the main driver of recent USD weakness and the seemingly improving Franco-German relationship – Germany’s Merkel said yesterday that France’s Hollande’s proposals were ‘sensible’ solutions to Europe’s debt crisis – may lead to further short covering.

Central banks on the front line

All of the above-mentioned data/events are crucial to market direction in the 2H ’12 due to its implications for monetary policy globally – extremely negative news-flow may see some initial spikes lower in risk but would ultimately lead to a rebound in risk assets and USD downside on an eventual implementation of QE3 and/or possible coordinated global intervention. However, the time to buy dips in risk hasn’t arrived just yet. US economic data, while mixed of late, has outperformed data out of Europe and traders are unlikely to take on large positions until Greek election results are out.

The RBNZ’s more dovish policy stance on intensifying external and domestic economic conditions has been the main driver behind the precipitous free-fall in NZD/USD. Markets have started ‘pricing in’ a hike to the OCR further out but have not quite ‘priced in’ rate cuts. We think this is a real possibility as suggested by commodity price downside and declining domestic consumption in China.

Technically, NZD/USD is in the midst of a potential H&S pattern on weekly charts; a break below neckline support around 0.7525, at the moment, projects a measured move objective to around the 0.6000 figure. On shorter term charts (see 4HR chart inset), the 50 pip false breakout below downtrend channel support suggests the most recent break above channel resistance may be false as well.

As both technical and fundamental indicators suggest further NZD/USD downside remains, we think reward: risk value favors kiwi shorts – Potential NZD/USD shorts for half a position at around 0.7680 with the remaining half on a potential retest of broken uptrend support around 0.7830 for a final average rate of 0.7755 with stops above triangle consolidation resistance at around 0.8255 for a total risk of about -500 pips and limits targeting a move above the H&S measured move objective at around 0.6255 for a total potential reward of +1500 pips may provide a 3:1 reward to risk opportunity.

Strategy of the week

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.